A right of renewal in a franchise agreement is a right which gives you the option to "renew" the franchise agreement at the end of the term.
Not all franchise agreements contain a right of renewal.
Even if your franchise agreement contains a right of renewal you may not want to renew the franchise agreement.
The Right of Renewal
If a franchise agreement does not contain a right of renewal, the franchisor does not have to extend the franchise agreement or grant you a new franchise agreement.
Since 2015 disclosure documents have been required to specify whether a franchisee has the right to renew the franchise agreement. Specifically, if the franchisee does not have the right to renew the franchise agreement, the following statement must be included in size 12 font and bold.
The franchisee does not have the option to renew the franchise agreement. At the end of the franchise agreement, the franchisor may, but does not have to, extend the term of the agreement. If the franchisor does not extend the term of the agreement, the franchise agreement ends and the franchisee no longer has the right to carry on the franchised business.
The franchisor must notify you in writing whether the franchisor intends to extend the franchise agreement, or enter into a new franchise agreement:
- at least 6 months before the end of the term of the franchise agreement, if the term of the franchise agreement is 6 months or longer; or
- at least 1 month before the end of the term of the franchise agreement, if the term of the franchise agreement is less than 6 months.
Does the Franchisor Have to Renew the Franchise Agreement?
If the franchise agreement contains a right of renewal and you want to exercise your right of renewal, you must follow the procedure set out in the franchise agreement, including providing the franchisor with notice of your intention to renew the franchise agreement within the required time frame.
If you do not advise the franchisor of your intention to renew the franchise agreement within the time period set out in the franchise agreement, the franchisor may not be required to renew the franchise agreement.
A franchisor can also refuse to renew a franchise agreement if you do not comply with the other conditions for renewal set out in the franchise agreement.
Generally, a right to renew a franchise agreement is subject to certain conditions such as:
- the franchisee not being in breach of the franchise agreement;
- the payment of a renewal fee;
- an upgrade of the fit out;
- the entry into a new franchise agreement (which may include terms and conditions that are different to the original franchise agreement, including financial terms and conditions that are different to the original franchise agreement).
Any refusal of the franchisor to renew the franchise agreement is subject to the obligation to act in good faith.
What if you do not exercise your option to renew the franchise agreement?
You may decide not to exercise your option to renew the franchise agreement.
The Federal Government in one of the proposed forms of the Key Facts Sheet provides that a franchisee should consider and check what the pre-conditions are for extending or renewing the franchise agreement. For example, whether the franchisee will be asked to spend a lot of money to renovate the site to get another term.
If you do not renew your franchise agreement and the franchise agreement expires, you may not be compensated for goodwill that you have built up in the franchise business. You may need to sell your franchise business before the expiry of the term of the franchise agreement (on the basis that the franchisor is prepared to grant the purchaser a new franchise) in order to be compensated for goodwill.
Further, the term of your lease and the term of the franchise agreement may not coincide. If the franchise agreement expires before the lease expires you may be obligated to continue to pay rent and outgoings for the term of the lease.
If you want to operate another business (including from the premises) you should review the terms of the non competition or restraint clauses contained in the franchise agreement.
Non Competition and Restraint
A restraint of trade clause is a clause which is included in an agreement typically to stop someone from competing or using confidential information. Whether a restraint of trade clause is reasonable or enforceable is usually considered by looking at:
- The scope of the activity restrained:
Any restriction should be limited to the scope of the franchised activity. For example, if you operated a noodle bar franchise, a restraint which applies to "operating a restaurant" or "operating a cafe" may be invalid. - The geographical area covered:
The geographical area should not be larger than necessary to protect the legitimate interest. For example, if the legitimate interest to be protected is the goodwill of the franchise business, then the area in which the franchise business was operated will be relevant to a consideration of what is reasonable. - The duration of the restraint.
If the legitimate interest includes the protection of goodwill or customers, the Court may consider whether the restraint period allows a sufficient time for the new franchisee to establish a relationship with the customers of the business.
If a restraint of trade clause is drafted too widely, or if there is another way to protect the interests of the party trying to enforce the restraint of trade clause, the clause may not be enforceable.
Clause 23 of the Franchising Code of Conduct (the Franchising Code) sets out a series of circumstances in which a restraint of trade clause contained in a franchise agreement has no effect after the franchise agreement expires. That is, in certain circumstances, after the franchise agreement expires, the franchisor cannot stop the franchisee from competing with the franchisor.
Broadly, the franchise agreement must have expired and the franchise agreement must not allow the franchisee to seek compensation for goodwill, or alternatively, if the franchise agreement allows the franchisee to seek compensation for goodwill, the compensation must be inadequate.
There are further conditions which we have set out in our factsheet.
Takeaways
- If your franchise agreement contains a right of renewal, ensure that the notice periods for advising of your intention to renew are diarised.
- If your franchise agreement does not contain a right of renewal, ensure that you receive notice from the franchisor as required in relation to the franchisor's intention to extend the franchise agreement or grant a new franchise agreement.
- Review the renewal terms set out in your franchise agreement so that you are aware of any conditions for renewal and in particular any fit out or upgrade provisions.
- Review your lease and consider whether the expiry of the lease and the expiry of the franchise agreement are consistent.
- Seek financial advice about any renewal costs (including upgrade costs) or changes to the financial terms of the franchise agreement.
- Seek legal advice about any renewal or new franchise agreement or the enforceability of any non-competition or restraint provisions.
Disclaimer
The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.
